Tax Day Question: Who Are the Rich and Why Should They Pay Higher Taxes?

On today's federal tax filing deadline, it just so happens that Congress and the Administration have been thinking of different ways to raise tax burdens on the rich. Last week I participated in a “Tax Day” event at the Tax Policy Center called “Should the Rich Pay Higher Taxes?”, speaking on a panel which also included TPC’s director Donald Marron, former CBO director and former McCain adviser Doug Holtz-Eakin (now president of American Action Forum), and economist rich guy (and a member of the “Responsible Wealth” coalition) David Levine.

TPC’s Howard Gleckman moderated the event (and blogged about it afterward, here) and at one point asked each of us “Who is rich?” I at first didn’t know how to answer that; “rich” is a relative concept that depends on one’s personal “baseline,” of course! But then I considered the focus of the event – what the tax burdens of “the rich” should be -- and I realized that in a sense, all of us, collectively at least, might be considered “rich,” in that U.S. taxes are quite low relative to our national capacity to pay them (the size of our economy). Revenues as a share of GDP are far lower right now than the 18 percent historical average over the past several decades.

And although a lot of that currently-below-average level is because of the short-term but stubbornly persistent weakness in the economy (a cyclical phenomenon), projections show that even when the economy gets back to “full employment"--even when revenues/GDP recover back to the historical average (if we extend the Bush tax cuts), or they go above the historical average (if we let the tax cuts expire), revenues are still not going to be enough to keep up with the growth in government spending. And that even assumes health reform successfully reduces the growth in Medicare spending.

So if “the rich” are defined as those who can afford and ought to be expected to pay higher income taxes, then “the rich” really has to be much more broadly defined than “people like David Levine” or Warren Buffett (who are multi-millionaires). And if you watch the video of the TPC event, you'll notice we all pretty much agreed on the premises that: (i) we need more federal revenue; (ii) “the rich” can manage higher tax burdens the best (and should be asked first); and (iii) David definitely qualifies as “rich.” Disagreements remain over: (i) how much more revenue we need (and implicitly and even more fundamentally, what the right size of government is); (ii) how that revenue should be raised in terms of base-broadening vs. rate-raising reforms; (iii) what the right basis of taxation is -- income or consumption -- and (iv) if David’s wealth comes more from his high productivity and hard work, or more from good luck -- and if raising marginal tax rates on people like David will cause them to not work so hard, or if it just means they will not be as “lucky” in terms of their tax burdens. (This last issue is an empirical question relating to the size of "income effects" vs. "substitution effects," a discussion that Donald and I both got into during the Q and A.)

David is practically begging to make him, and other millionaires like him, pay higher taxes, and feels the easiest initial step towards exercising the "Buffett Rule" and ensuring that the rich face higher effective tax rates than middle-class families is to brute-force raise marginal tax rates on the incomes of the rich, via another alternative minimum tax such as the proposal taken up by the Senate on Monday (which received majority support but not the 60 votes needed to advance the legislation). But David would ultimately want a less AMT-like solution and would most like to see new top tax-rate brackets at very high income levels (above $1 million or $5 million).

Donald and I agreed that David can afford to face a much larger tax bill, but that it would be better (more economically efficient and better for supply-side incentives) if his burden were raised by paring back the tax subsidies David receives from, for example, itemized deductions and the preferential tax rates on capital gains and dividend income.

I feel that conservatives (like Doug) who want lower marginal tax rates tend to over-sell the significance of those rates in effecting growth, but liberals (even rich ones like David) tend to forget that as long as high marginal rates lead to some degree of inefficiency in revenue raising, it’s better to raise tax burdens by broadening the tax base (in a progressive manner) than by raising the top marginal tax rates.

So the TPC event made clear that “yes, the rich should pay higher taxes.” But it also highlighted where the challenges to achieving fundamental tax reform will be, in coming to agreement about who exactly is “rich,” and how exactly they will be made to pay more in taxes. We have far more work to do regarding federal tax policy than what is currently being debated -- in a very narrow sense -- about the “Buffett Rule.”